The market for offset credits to mitigate deforestation is growing, but investors and other
stakeholders require that guidance be provided in accounting for them.

Over the last 20 years, as the forestry carbon market has matured, it has developed into an
alternative investment asset class. Forestry carbon projects typically address deforestation of the
tropical forests lining the Equator, where deforestation occurs at a rate of 32 million acres per
year. Deforestation accounts for approximately 20% of annual global greenhouse gas (GHG) emissions.

A recently published report, entitled Financial Accounting for
Forestry Carbon Offsets, serves both as an introduction to forestry carbon offsets as an
alternative asset class, and an analysis of the methods of accounting for forestry carbon offsets.
The report was
authored by Gabriel Thoumi, a consultant with Forest Carbon Offsets, and Talitha
Haller of the Social Carbon Company in
Brazil.

The authors assert that by providing economic incentives for achieving emissions
reductions through such means as cap-and-trade programs, "we can develop a financial asset from an
environmental liability." Companies purchase forestry carbon offset credits for a number of
reasons, according to the report, including regulatory compliance, investing for financial return,
and public relations.

Recent significant purchases of forestry carbon offset credits
include the purchase in July of 600,000 metric tons by Pacific Gas and Electric (PG&E), for a price
of $9.71 per ton. PG&E purchased the emission reductions from The Conservation Fund, which is
sustainably managing the growth of 16,000 acres of redwood and Douglas fir forests on the Mendocino
Coast in California.

Yet at present, "The International Accounting Standards Board (IASB)
and the US Financial Accounting Standards Board (FASB) offer no guidance on how entities should
account for voluntary emissions reductions, including forestry carbon offsets," according to the
report.

Howard of Social Carbon said, "Financial accounting methods are important for
investors looking for the credibility of projects."

Successful forestry carbon offset
projects have four major components. They need to be adaptive to the requirements of the
environment in which the project occurs. Companies must work with local communities in order to
gain support for their projects. Business is advised to work with national and regional governments
as well, to develop international standards of best practice that mitigate legal risk. Finally, in
structuring risk, companies must keep in mind that a successful project focuses on mitigating
risks, as opposed to maximizing profits.

According to the report, "Because forestry carbon
projects should directly improve carbon sequestration and indirectly improve other ecosystem
services, it is possible to discuss forestry carbon assets as value creation projects." Since
forestry carbon projects usually span 20 to 100 years, they can be described as intergenerational
in scope.

As an alternative investment asset class, forestry carbon projects have specific
risk and return profiles, depending on the long-term sustainability of the project. Investors may
be attracted to the idea of reducing emissions, while enjoying tax breaks that may come with
forestry investment.

Unfortunately, while the role of financial institutions in the
growth of forestry carbon projects is critical, their operations are too seldom congruent with
sustainability. The report identifies three critical flaws in current financial analysis:
"discounting without a rational time horizon, accounting for natural resources that does not
reflect ecological resources, and the separation of growth and development as applied to infinite
and finite resources."

Observing that global forestry carbon projects are growing in
number and size, the report states that the market has yet to develop consistent institutional and
regulatory frameworks. "Appropriate and uniform classification of forestry carbon offsets in the
financial statements is imperative both for internal decision-making and for external stakeholders
such as investors," because "Without clear accounting guidance for forestry carbon or voluntary
offsets, comparability across projects will remain vague."

"If the market is really going
to become active and viable," said Howard, "Then we're going to need uniform accounting principles
across all stakeholders."

In order to provide guidance for a uniform system of accounting
principles, the report compares the classification methods of inventory and intangible assets. "If
an entity sells forestry carbon offsets as part of its normal operations, or uses them to settle
emissions liabilities in its ordinary course of business, offsets could classify as inventory,"
according to the report.

The report says of the inventory classification, "If an entity is
concerned with analyst following and attractiveness to investors, it may consider accounting for
credits as inventory."

Because future benefits are expected to flow to an entity as a
result of forestry management, forestry carbon offsets can be classified as intangible assets as
well. Accounting for forestry assets as intangibles results in no balance sheet recognition, but in
expenditures on the income statement instead.

"When offsets are recorded as off-balance
sheet intangibles, costs are expensed as incurred; these expenses are not matched with relevant
sales proceeds," the report states. "As a result, accounting for forestry offsets as intangibles
will lead to greater earnings volatility."

"With intangibles, you don't have those assets
on your balance sheet," Howard said. "You may lack credibility with outside stakeholders."

To gain an understanding of how emission reductions have been accounted for thus far, he report
makes reference to a 2007 survey of 26 European organizations affected by the EU Emissions Trading
Scheme (ETS), conducted by PricewaterhouseCoopers and the International Emissions Trading
Association (IETA). The survey found that 29% of participants accounted for Certified Emission
Reductions (CERs) as inventory, while 13% recorded them as intangible fixed assets.